ETF Trends
ETF Trends

Food price inflation is increasing sharply in the US. Only last December 2013, food prices were just 1.05% higher than the previous December. As of May 2014, food price inflation was running at 2.46% (year over year) and possibly heading above 4% by late 2014 or early 2015. Now, the Federal Reserve (Fed) prefers to target core inflation, which leaves out the volatile food and energy sectors.

When food inflation is rising along with incremental increases in core inflation, however, the Fed can be expected to take this into consideration. Further, if the incremental increases in core inflation come along at the same time as the unemployment rate declines below 6%, which we expect to happen in the second half of 2014, then the probabilities increase for the Fed to raise its target federal funds rate sooner rather than later in 2015.

Higher food prices in the US are primarily related to the droughts in the vegetable and fruit growing areas of California as well as the livestock regions around north Texas and southern and western Oklahoma. And, even as we monitor the drought in California, it is important to note that there are signs over the equatorial Pacific Ocean of the warmer than usual water temperatures that have the potential to give rise to an El Niño event.

If, and this is by no means a certainty yet, an El Niño event develops, then the impact on weather patterns around the world can be quite striking, yet with many of the effects coming with a lag. The direct impact of warmer water is more evaporation and then more precipitation, depending on where the winds blow. And because El Niño events are associated with oscillations in air pressure patterns, wind and jet stream track shifts can drive where the rain (or snow) falls and where it does not. If an El Niño event occurs, we would expect more rain in Ecuador and Peru, southern Brazil and northern Argentina, but less rain in Australia.

The impact on the US tends come with a little longer time lag and eventually may involve a stronger storm track across the southern parts of the US and less stormy and milder winters in the northern sections of the country. The California drought could be eased in the process, but with a greater probability of quite severe weather.

Hurricane formation is impacted by the shifting wind patterns, which can lessen the ability of the storms to develop off the west coast of Africa in the tropical Atlantic. Hurricanes may still form, as Arthur did in early July, in the warm waters southeast of Florida and in the Caribbean Islands. What El Niño events underscore is how connected world weather patterns are, which emphasizes the global nature of agricultural markets.

This article was written by CME Group Chief Economist Bluford Putnam.

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